Company Ownership and Capital Structure

Company Ownership and Capital Structure Jie (Michael) Guo, Li Ding and Ji Sun*

June 5, 2010

Abstract

This paper examines the effect of ownership structure on firms’ leverage level, using a

sample of 365 UK firms from 1997 to 2009. The study also investigates the influence of

ownership on firms’ external finance decisions, and further analyzes this impact under

different stock market conditions, by observing 273 debt and 289 equity offerings during the

same period. As the empirical results show, in the sample of all companies the effect of

ownership concentration on market leverage is negative, which is consistent with the

argument that large shareholders are more averse to increasing the debt level, because of

the risk of bankruptcy and financial distress. However, in firms with low ownership

concentration the effect is positive. We also find that the change in firms’ leverage around the

security issuance is positively associated with the level of ownership concentration, indicating

that firms with highly concentrated ownership are more likely to choose more debt and less

equity issuance than are firms with dispersed ownership. Moreover, the impact of ownership

concentration on firms’ external finance decisions varies under different stock market

conditions. The impact is insignificant when the stock market is cold, but exists under median

and hot stock market conditions.

Keywords: Ownership, Capital Structure, Stock Market Conditions, Security Issues, Agency

Theory

Author for correspondence, Ji Sun; contact address: Durham Business School, Durham

University, Mill Hill Lane, Durham, DH1 3LB, UK. Email: [email protected]

1. Introduction

While a large number of prior studies have demonstrated that ownership structure is an

important instrument to improve firm performance (Jensen and Meckling, 1976; Shleifer and

Vishny, 1986; Morck, Shleifer and Vishny, 1988; Demsetz and Lehn, 1985; McConnell and

Servaes, 1995), the relations between ownership structure and capital structure remain

largely unexplored. The extant literature is scarce but mixed. Grossman and Hart (1986) and

Anderson et al. (2003) confirm that firms with a high ownership concentration structure have

higher leverage level than firms with dispersed ownership, but Nam et al. (2003) find the

opposite outcome. In addition, Brailsford et al. (2002) suggest that the impact of ownership

on leverage is nonlinear, varying across the level of managerial share ownership. Moreover,

ownership structure as a crucial determinant in corporate governance is closely associated

with cost of debt and equity financing. Lundstrum (2009) finds a negative relationship

between managerial share ownership and the magnitude of leverage change before

issuance. Therefore, there seem to exist links between ownership structure and firms’

external financing decisions. With regard to market timing theory, firms’ choice of debt or

equity is also highly associated with current stock market conditions. If the stock market is hot,

firms will consider equity issue as a first choice; if not, they might favour debt financing.

However, no previous study has linked the impact of ownership concentration on external

financing policy with market timing theory, to check whether this impact changes with different

stock market conditions.

In this study, we attempt to interpret whether ownership concentration affects firms’ external

financing decisions, and thus capital structure, in the context of large shareholders’ behaviour

and agency theory. Shleifer and Vishny (1986, 1997) find that according to the efficient

monitoring hypothesis, large external shareholders have strong incentives to monitor and

discipline management in order to mitigate agency cost. Grossman and Hart (1986) further

indicate that shareholders with large stakes can gain internal benefit from their monitoring.

Moreover, large shareholders are usually risk averse, so that they may avoid undertaking

investment with high risk premia, resulting in the under-investment problem (Demsetz and

Lehn, 1985).

In contrast, diversified shareholders are more interested in undertaking risky projects with high

expected return at the expense of bondholders’ wealth (Jensen and Meckling, 1976). This is

because diversified shareholders can obtain the excess returns if the investment is successful,

while creditors bear the cost of failure. As a result, creditors demand higher debt cost.

Furthermore, dispersed ownership may weaken the monitoring mechanism, due to the free

rider problem (Grossman et al., 1980).

In addition, the divergence between voting right and cash flow right means that controlling

shareholders tend to consume the corporate resources, while the minority shareholders

cannot share the advantages (Morck, Shleifer and Vishny, 1988; Holderness, 2003).

Furthermore, larger shareholders potentially expropriate minority investors in the firms with

high concentrated ownership (La Porta et al., 1999; Denis and McConnel, 2003). Johnson et al.

(2000) put forward the term “tunnelling” to describe how controlling shareholders extract

private benefit from firms’ assets and resources.

Based on the argument above, we begin by examining whether ownership concentration might

affect firms’ leverage level, and then test the effect of ownership on firms’ external financing

decisions. Most prior evidence shows that firms with high ownership concentration have higher

leverage levels (Grossman and Hart, 1986; Anderson et al., 2003). Controlling shareholders

prefer debt to equity financing, since they tend to maintain their level of voting control for a

given level of equity. Moreover, a higher level of debt can reduce the risk of the firm becoming

a takeover target. However, shareholders in firms with dispersed ownership are willing to

diversify their risk to invest in different firms and in risky projects, so that they may expropriate

the creditors’ interest (Jensen and Meckling, 1976). As a result, debt holders will demand

higher interest on debt to compensate their potential loss, and thus the cost of debt financing

increases.

With regard to the negative impact of ownership concentration on firms’ leverage, the

explanation is built on the theory that the controlling shareholders wish to reduce the control

risk exposure; hence they are more averse to the risk of financial distress and bankruptcy that

follows high debt level (Mishra and McConaughy, 1999). However, some scholars argue that

ownership structure is an exogenous variable, which does not influence firm performance and

leverage (Chaganti and Damanpour, 1991; Anderson and Reeb, 2003).

In order to explore these issues fully, the following two hypotheses are developed and tested in

this study:

Hypothesis 1: Ownership concentration does have an influence on firms’ leverage level.

Hypothesis 2: Ownership concentration has a positive impact on the leverage change around

the security issue.

The other important objective of this paper is to test the impact of ownership on leverage

change around a security issue under a range of stock market conditions: hot, median and

cold. According to market timing theory, the current market conditions play an important role in

capital structure decisions. Firms are likely to issue shares when their stock price is high, and

repurchase shares or choose debt issuing when their stock price is low. Graham and Harvey

(2001) found that two-thirds of CEOs admit that market timing is an important consideration for

capital structure. Later, Baker and Wurgler (2002) proposed that firms tend to raise external

funds when their cost of equity is temporarily low, and that past market timing decisions have

long-lasting impact on leverage. Moreover, Welch (2004) concludes that fluctuations of firms’

own stock price is a primary determinant of debt-equity ratio and that the effect is permanent.

Moreover, Pedersen and Thomsen (2000) consider the condition of the stock market as a

determinant likely to affect firms’ ownership. When the stock market is hot, firms’ stock prices

are overvalued so that managers prefer to issue equity and sell shares, resulting in dispersed

ownership (Pedersen and Thomsen, 2000). In contrast, if firms’ stock prices are undervalued,

managers will tend to repurchase shares to raise the stock price, causing ownership to

become more concentrated.

Therefore, the third hypothesis extends Hypothesis 2 and links it with market timing theory:

Hypothesis 3: The impact of ownership on firms’ choice of debt or equity will vary according to

different stock market conditions.

The present study measures ownership concentration according to the percentage of shares

owned by block holders; this data is hand collected from Thomson ONE Banker. In the first

stage, we test whether ownership concentration affects firms’ leverage, using the sample of

365 UK firms during the calendar years 1997-2009. Financial and utilities firms are excluded

from the research sample. Subsequently, we observe the relation between ownership

concentration and firms’ external financing behaviour, using 273 debt and 289 equity offerings.

Then we apply three proxies - cumulative stock market return, P/E ratio and equity issue

volume - to divide stock market conditions into hot, cold and median periods. Thus this study

examines how the impact of ownership concentration on the magnitude of leverage change

around security offering varies across distinct stock market conditions. In addition to the three

motivations, our empirical tests also examine the other determinants of ownership structure:

firm size, market-to-book ratio, tangibility, sales growth, capital expenditure, dividend, tax rate,

non-debt tax shield and credit rating.

The results of this study show that ownership concentration does have significant impact on

firms’ leverage level, and this impact varies according to different samples selected. In the

sample of all companies, the results present the negative effect of ownership on book

leverage, supporting the theory that controlling shareholders are more averse to increase the

debt level because of the risk of bankruptcy and financial distress. In contrast, the opposite

effect is found in the firms whose ownership concentration is in the range of 0%-25%. In the

firms with wide ownership, the large external shareholders desire to restrict managers’

entrenchment by debt financing. We further find that the firms’ leverage change around

security issuance has positive impact on the level of ownership concentration. In other words,

firms with high concentrated ownership are more likely to choose more debt and less equity

issuance than are firms with low ownership concentration, which is consistent with

Lundstrum’s (2009) analysis. As we posited, the impact of ownership concentration on firms’

external financial decision varies across different stock market conditions. The impact is

insignificant in cold stock market conditions, but significant during median and hot stock

market periods. Moreover, the results are robust to test other effects of firms’ characteristics

on capital structure. Firms’ profitability, sales growth and tangibility and dividend are

negatively related to leverage level. However, the influences of firm size, market-to-book ratio

and non-debt tax shield on leverage are positive and significant.

This paper contributes to addressing three important gaps in the prior literature. First, although

ownership structure has been widely accepted as an important tool to mitigate agency cost

and improve firm performance, very few studies have analyzed the impact of ownership on

capital structure, especially in the UK market. Prior literature reveals that UK firms are more

likely to possess high leverage ratio, as a result of the junk bond problem. Although UK firms

tend to be in dispersed ownership, investors nevertheless hold relatively large equity stakes

(Mayer, 2000). Furthermore, most large shareholders are financial institutions, but they do not

take a very active role in monitoring management. Franks et al. (2001) propose that most

parties in UK firms, including block holders and boards of directors, exert a weak monitoring

function. These arguments suggest that managers in UK firms may be more entrenched to

pursue their own interest, regardless of whether the firms carry optimal leverage ratio.

Therefore, this paper analyzes the relation between ownership concentration and capital

structure with reference to specific features of UK firms.

Second, few papers have shed light on the extended impact of ownership concentration on

firms’ external financing policy. According to the pecking order theory, adverse selection leads

managers to consider internal funds as a first choice, followed by debt issue, and with equity

issue as a last resort. Large shareholders favour debt rather than equity issue, in order to

maintain their voting and control power and to monitor the corporate governance in the

concentrated ownership firm. In addition, debt financing effectively limits managers’ behaviour,

such as the private benefits of control, because block holders have greater incentives to

monitor management than do dispersed shareholders. Furthermore, debt financing is an

efficient mechanism to assist creditors to discipline the controlling shareholder and to impose

constraints via covenant (Shleifer and Vishny, 1986, 1997). In general, family owned firms

prefer debt issue, due to their long-term commitment to the business; thus they usually bear a

lower cost of debt financing (Anderson et al., 2003). Nevertheless, in the firms with low

ownership concentration, managers are likely to issue equity, in accordance with pecking order

theory. On the one hand, managers desire to avoid the pressure of paying interest on debt. On

the other hand, they are unwilling to be monitored by outside investors and creditors. Moreover,

managers may issue less debt in order to shield firms from the risk of bankruptcy and financial

distress, since they want to protect their own positions.

Third, to date no paper has investigated whether the relation between ownership concentration

and leverage change around security issuance changes under different stock market

conditions. In practice, managers investigate the current market conditions before they make

capital structure decisions, which is the core of market timing theory. When the stock market

condition is hot, investors are over-optimistic and consequently, stock prices are overvalued.

This increased market value can directly generate lower leverage level for firms. Moreover,

managers may perceive the hot stock market condition as a good opportunity to raise capital

by issuing equity, further reducing the firm’s debt ratio. If the stock market is not bullish,

managers will defer equity issuance. From another point of view, seasoned equity offering

(SEO) can be considered as a “right offer” to existing shareholders. In that situation, the equity

offering may reduce the level of ownership concentration in that shares are sold to institutions

and other outside investors. The asymmetric information related to firms’ fundamental value

existing between managers and external shareholders will affect the willingness of

shareholders to participate in an equity offering (Eckbo and Masulis, 1992). In a hot stock

market, clustered equity issue is likely to result in decreased ownership concentration. Thus it

seems that stock market conditions affect not only firms’ debt-equity choice, but also the level

of ownership concentration, which is good reason to believe that stock market conditions might

influence the impact of ownership on firms’ external financing decisions.

The rest of the paper is organized as follows. Section 2 describes the sample selection,

definition of variables and model design. Section 3 presents the empirical results and

discussion. Conclusions are presented in Section 4.

2. Sample Selection, Definition of Variables and Model Design

This section describes the sample selection and the data sources. All the variables used in the

empirical work have been defined and analyzed in previous literature, particularly in discussion

of the measures and proxies of capital structure, ownership concentration and market

conditions. The section concludes by presenting two leverage equations.

2.1 Sample selection

In order to examine the impact of ownership concentration on firms’ leverage, the sample

consists of all of the UK firms listed on the London Stock Exchange. Due to the limited

ownership information provided by Thomson ONE Banker, the research period is restricted to

13 years, from 01/01/1997 to 31/12/2009. Financials (SIC code 6000-6999) and utilities (SIC

code 4900-4949) are eliminated from the sample. This is because the leverage ratio in

financials is significantly different from that in non-financials, and the utility industry takes a

regulatory role, with limited scope for corporate control activity (Leonard, 2008). Thus, the

sample is reduced from 606 to 365 companies.

The second motivation of this paper is to investigate how ownership concentration affects

leverage change during different stock market conditions. Therefore, we should observe all UK

firms’ bond and equity issuance shown on Thomson ONE Banker during the 13-year period.

We focus on relatively large offers, whose value exceeds USD 100 million. After excluding

financials and utilities, the sample size is reduced to 1372 debt offers and 5038 equity offers. In

addition, the IPO-related equity issuance is removed from the database, because this paper

lays emphasis on listed firms. We match the ownership and accounting data with the offering

activity, and thus the final sample is shrunk into 273 debt and 289 equity issues.

There are two sources to obtain the data. We download the accounting and market data for the

sample period 1997-2009 from Thomson DataStream. The information of ownership and

issuance is derived from Thomson ONE Banker. It is worth mentioning that the data about

ownership is hand collected, since it can only be downloaded one company at a time, one

quarter at a time. For each company, the following terms are included: the equity ownership

of the top three largest shareholders and all block holders (>5%), large shareholder type, and

global region. We exclude observations where the total percentage of block holders exceeds

100%.

2.2 Variable definitions and predictions

Leverage

Prior literature has developed various indicators of capital structure. Scholars measure debt in

a variety of ways, such as book valuation or market valuation of debt, total debt or long-term

debt only. Welch (2004) uses interest coverage ratio as the measure of leverage.

Following Fama and French (2000), leverage is defined in two ways: book leverage and

market leverage. The detailed definitions are presented in Table 1.

Ownership concentration

Demsetz and Lehn (1985) measured ownership concentration (OC) as the fraction owned by

the five, ten or twenty largest shareholders. Subsequently, Earle et al. (2005) explored

alternative ownership concentration measures to capture some important aspects of

interactions among large shareholders and the pattern of concentration that may influence

the effect of ownership on leverage. With this in mind, we employ OC to measure ownership

concentration, in which a block holder is defined as owning over 5% of a firm’s share

(Worldscope/Disclosure, 1997). Ownership holding has been classified into three ranges: low

concentration (0-25%), intermediate concentration (25-50%) and high concentration (>50%).

Large shareholders or block holders have more incentive to monitor corporate governance in

order to align the management with their interest, resulting in lower agency conflict between

managers and shareholders (Shleifer and Vishny, 1986). The intention of managers is to

maintain viability in the firm, thus reducing the level of debt, since increased debt leads to

high bankruptcy cost. In short, firms with higher external block-holding are expected to have

a relatively lower leverage ratio, because managers’ pursue their own interest to reduce the

debt level in capital structure.

Investor type is also highly related with leverage ratio. Family controlled firms with high

ownership concentration are more likely to have efficient monitoring of management, in order

to reduce the agency conflict between owner and manager (Morck et al.,1988; Anderson and

Reeb, 2003). However, the conflict of interest between large shareholders and minority

shareholders becomes more serious. Moreover, family owned firms value control more highly

than do non-family owned firms. Thus they may prefer debt financing rather than equity.

Institutional investors have the resources and ability to monitor corporate management.

However, they pursue high return and risky projects, causing reduced monitoring efficiency,

because of the diversified shareholders who invest in multiple firms (Coffee, 1991; Black,

1992; Tufano, 1996). Therefore, managers are more entrenched in those firms owned by

institutional investors. Otherwise, financial institutions as large shareholders make firm

finance easier, but investment strategy is limited (Friend and Lang, 1988).

Other variables

In addition to ownership structure, firms’ leverage level is affected by other factors, which can

be divided into firm-specific characteristics such as profitability, firm size, market-to-book

ratio, tangibility, sales growth, capital expenditure, dividend, tax rate, non-debt tax shield and

credit rating. The impact of each factor on capital structure decisions is indicated according to

prior theories. Moreover, we use three proxies to identity hot and cold stock market

conditions. Table 1 presents descriptions of these factors and the data sources.

Profitability

The effect of profitability on leverage has long been argued (Harris and Raviv, 1991; Rajan

and Zingales, 1995; Booth et al., 2001), but results have been inconsistent. More profitable

firms not only have lower cost of bankruptcy and financial distress, but also seem to have

efficient management. Moreover, in firms with high profitability, the use of debt as a

monitoring mechanism is more likely to solve the free cash flow problem (Jensen, 1986).

Thus profitable firms use more debt financing.

However, the pecking order theory indicates that firms should choose internal cash flows as

the first option for financing, before considering external financing. More profitable firms

should retain more of their earnings to invest in new projects, but less profitable firms will

resort to debt financing. This negative impact of profitability on debt level may be challenged

by the presence of large investment (Booth et al., 2001).

Firm size

In Frank and Goyal’s (2007) survey of trade-off and pecking order theory, larger firms have

relatively low leverage ratio. Because larger firms are more diversified and have better

management, they face lower default risk (Friend and Lang, 1988). In addition, larger firms

may have more experience of the market and employ outstanding managers, which will bring

about higher firm efficiency. In contrast, small firms actively use equity financing.

Growth opportunities

Firms’ growth opportunity can be measured by market-to-book ratio, sales growth and capital

expenditure. According to trade-off theory, growth of firm increases the cost of financial

distress, weakens the free cash flow problem and exacerbates agency cost of debt (Frank and

Goyal, 2009). Thus the growth opportunities reduce leverage ratio to a certain extent.

Furthermore, due to various kinds of disclosure practices and lender-borrower relations, the

role of growth may vary across different countries. Antoniou et al. (2008) state that the

negative impact of firms’ growth in capital market-oriented economies is stronger than that in

bank-oriented economies.

The market-to-book ratio is the most widely used indicator to predict firms’ growth

opportunities, and it can capture the change of leverage brought by equity mispricing.

According to the asymmetric information theory, over valuation will make firms issue equity;

but when stock price is undervalued, firms purchase shares or issue debt. Therefore, firms

with higher market-to-book ratio should lower debt level by equity issuance. However, as

described by the pecking order theory, firms consider debt as the first choice of external

financing, and only then resort to equity issuance. In this case, the growth opportunities should

have a positive impact on leverage.

Sales growth is considered by previous literature as an alternative measure of firms’ growth.

Low growth firms will have fewer opportunities to substitute low risk for risky and high return

investments; hence they should face lower agency costs of debt and may be able to carry

more debt in their capital structure. High growth firms on the other hand may face a more

intense debt overhang problem, as described by Jensen and Meckling (1976) and Myers

(1977). In other words, the effect of sales growth on leverage is positive. This impact is more

significant in small, family-owned firms, where there is a fear of losing control to the bank.

Tangibility

The tangibility of the firm’s assets is closely associated with agency costs of debt and the costs

of financial distress (Myers, 1977; Booth et al., 2001). Firms with more tangible assets have

greater ability to secure debt because these assets can be used as collateral (Jensen and

Meckling, 1976). Furthermore, in a bankruptcy situation tangible assets have more market

value than do intangible assets; hence the bondholder will demand a lower risk premium. This

indicates that asset tangibility has a positive effect on leverage (Titman and Wessels, 1988).

Moreover, the use of collateral plays a more important role in countries where creditor

protection is relatively weak, such as France (La Porta et al., 1998). Firms with lower fixed

assets may have more opportunities to expropriate bondholder interest by substituting safer

projects for riskier projects (Booth et al., 2001; Anderson et al., 2003).

Dividend payout ratio

Based on the agency cost and market efficiency theory, dividend payout ratio is considered as

a prominent factor to impact adversely on leverage (Rozeff, 1982). However, Chang and Rhee

(1990) argue that firms with high dividend payout ratio are more likely to issue more debt than

are firms with low payout ratio, because the effective capital gain tax rate is lower than the

dividend tax rate.

Taxes

The effect of tax on leverage ratio is measured by two variables: tax rate and non-debt tax

shield. The trade-off theory posits that firms will extend the amount of debt to take advantage

of greater interest tax shields (Haugen and Senbet, 1987). DeAngelo and Masulis (1980)

demonstrate that non-debt tax deduction can be used to describe the tax shield benefits of

debt. Depreciation ratio, net operating loss carry forwards and investment tax credit are

employed as proxies for non-debt tax shield (Titman and Wessels, 1988).

Credit rating

As argued by pecking order theory, firms which have higher ratings have less adverse

selection problems, because credit rating involves a process of information revelation by the

rating agency, for example S&P Credit Rating and Moody Rating. Firms with a higher

reputation in the debt market may issue more corporate bonds (Denis and Mihov, 2003).

Moreover, Sufi (2007) explores a new measure of information asymmetry though using the

credit ratings from Standard & Poor’s.

Stock market conditions

Price-earnings ratio (P/E ratio) has long been used to measure stock market conditions.

Jeremy Siegel (1998) argues that the earnings yield is a good indicator of the market

performance in the long run.

We also employ equity issue volume and cumulative market return as proxies of stock market

condition. According to market timing theory, firms rebalance their leverage across different

stock market periods. Welch (2004) observes that firms’ leverage ratio undergoes obvious

change after shock to the stock price. He also claims that stock return can explain 40 percent

of the variation in corporate debt ratio change. Moreover, due to the information asymmetry

between managers and outside shareholders, manager should time the equity market to sell

shares when stock prices are overvalued. Lucas and McDonald (1990) investigated stock

price behaviour around equity issues and found that on average, equity issues are preceded

by an abnormal rise in the market. Therefore, equity issuance is clustered following the run-up

of stock price.

In this study, we calculate the cumulative market return and cumulative equity issue by

de-trended monthly moving average market return and the volume of equity respectively.

The hot (cold) stock market condition is defined as those ranked in the top (bottom) 30% of all

quarters during 1997-2009, referring to p/e ratio, cumulative market returns or cumulative

equity issues. Those between 30% and 60% can be defined as median stock market

conditions.

(Please insert Table 1 here)

2.3 Model design

This paper uses three models. One is used to test the impact of ownership concentration on

leverage. The second is applied to examine how various ownership concentrations affect

firms’ debt-equity choice and the magnitude of offerings. The third is to test whether the effect

of ownership concentration on external financing policy changes with different stock market

conditions.

(1) Regressing leverage on ownership concentration

Leveraget = α0 + α1OCt + α2Profitabilityt + α3firmsizet + α4Mbratiot + α5salesgrowtht +

α6tangibilityt + α7dividendt + α8taxratet + α9nondebttaxshieldt + ut

(2) Regressing leverage change on ownership concentration by debt and equity issues

respectively

Leverage change = α0 + α1OCt + α4Profitabilityt + α5firmsizet + α6Mbratiot + α7salesgrowtht+

α8tangibilityt + α9dividendt + α10taxratet + α11nondebttaxshieldt +

α12creditratingt + ut

(3) Testing the impact of ownership of firms’ issue activity under different stock market

conditions

Leverage change = α0 + α1OC + α2D1 + α3D2 + α4Profitabilityt + α5firmsizet + α6Mbratiot +

α7salesgrowtht+ α8tangibilityt + α9dividendt + α10taxratet +

α11nondebttaxshieldt + α12creditratingt + ut

In regression 3, the stock market is separated into three conditions - cold, median and hot -

by using cumulative market returns, P/E ratio and cumulative equity volumes. As mentioned

above, firms’ increased (decreased) market value can directly generate lower (higher)

leverage ratio. In order to remove this effect, the variables D1 and D2 are applied in this

analysis. Thus, cold stock market is set as a dummy variable, equal to 0, when the stock

market condition is ranked in the bottom 30%, and 1 otherwise. Hot stock market is also a

dummy variable, equal to 1 when the stock market condition is in the top 30% of the whole

research period and 0 otherwise. D1 is defined as OC times cold stock market dummy. D2 is

defined as OC times hot stock market dummy.

Book leverage is defined as book debt over total asset. Market leverage is the ratio of book

debt to market value. Book change is the ratio of proceed amount to total asset. Market

change is the ratio of proceed amount over market value. OC represents the sum of shares

held by block holders. Profitability is earnings before interest, taxes and depreciation (EBITDA)

over total debt. Firm size is expressed as the log of total sales. Mb ratio is market value of

asset. Sales growth is measured by change in log of total asset. Tangibility is calculated as

tangible asset over total asset. Dividend expresses common dividend payout ratio. Tax rate is

defined as ratio of taxes paid to pre-tax income. Non debt tax shield denotes non-debt tax

shield. Credit rating is a dummy variable that is equal to 1 when firms’ S&P bond rating is

above A-, and 0 if below A-.

3 Empirical Work

Descriptive statistics

Table 2 presents descriptive statistics of firm characteristics by 365 sample companies from

1997 to 2009. The companies are separated into four groups by ownership concentration: all

companies, and high, intermediate and low ownership concentrated firms. In the UK firms,

the mean of book and market leverage are 56.92 % and 37.52% respectively. These ratios

are quite high compared to other countries, for example the US market from 1965 to 2001

(Flannery and Rangan, 2006), and Brazil and Mexico for the period 1985-1991 (Booth et al.,

2001). This might be explained by the junk bond problem, which means that it is easier for UK

firms to issue debt without having a high credit rating. However, those high-yield bonds bring

high possibility of default.

The average of ownership concentration (OC) is around 33.50% in the intermediate range,

suggesting that large shareholders may take an inactive role in monitoring management and

that managers may be more entrenched to pursue their own interest, regardless of whether

the firms carry optimal leverage ratio. The majority of UK firms have a low level of OC, and

only 20.6% have high OC. Columns 5 to 13 highlight the difference among the firms with

various levels of OC. It is worth noting that firms with higher levels of OC have smaller

amounts of debt than do those with dispersed ownership. This suggests that controlling

shareholders are more averse to increase the debt level because they fear the bankruptcy

risk that accompanies high OC. We also find that low OC firms have a dividend payout ratio

(11.20%) that is considerably higher than the average level (8.94%).


In Table 3, panel A shows all security issues in each year from 1997 to 2009, comprising

1216 debt and 3733 equity issuances. As shown in columns 2 and 4, there are only 52 debt

issues in 2008, but their proceed amount is the largest during the research period, at USD

331 million. We also notice that the equity issuances are significantly smaller than debt

issuances. This evidence demonstrates that firms make financing decisions by adverse

selected cost, preferring debt rather than equity issues, consistent with the pecking order

theory.

In panel B and panel C, we use the firms’ accounting data matched to issues and divide the

issues into four groups by OC. As shown in panel B, only 12 debt issues (4.4% of the total

debt issue) come from high OC firms. Conversely, the number of debt issues from low OC

firms is 210 (76.92% of total debt issues). From this panel, we observe that the firms with

higher OC hold greater leverage ratio, implying that the high OC firms prefer to issue debt as

their first choice of external financing, because control shareholders fear the dilution of voting

right that results from equity issue. However, panel C depicts evidence of the opposite

scenario, whereby firms’ debt is reduced with increased level of OC, which supports the

conclusions from Table 2.

Comparing the accounting data in panel B and panel C, we find that firms’ financing decision

may be affected by firm size. Larger firms prefer debt issue but smaller firms are more likely

to issue equity. Consistent with Friend and Lang (1988), larger firms have higher credit rating

and reputation, so that their cost of debt should be relatively lower than for smaller firms.


Table 4 reports the cross-sectional regression of leverage on ownership concentration. We

use different samples to test the impact of OC and other firm characteristics on leverage level.

The results support the proposition that ownership concentration has significant impact on

leverage level, but this impact is not monotonic across various levels of ownership

concentration.

Column 2 reveals that the effect of OC on book leverage is negative at 1% level. The high OC

firms tend to maintain their leverage at a lower level. As argued by Mishra and McConaughy

(1999), higher debt level is followed by higher probability of financial distress and bankruptcy,

so that the block holders are more likely to maintain a lower debt level to reduce their control

risk exposure. Moreover, we find that the relation between ownership concentration and

capital structure is absent in the firms with high OC and intermediate OC, but significantly

positive in firms with dispersed ownership (low OC). This evidence supports the view that

high OC firms should exhibit higher financial leverage, as controlling shareholders maintain

their voting control for a given level of equity.

Profitability has a significantly negative coefficient (shown in columns 3, 4, 5, 7, 8 and 9). This

is consistent with the pecking order theory. As posited, firm size has significantly positive

impact on debt ratio at 1% level in all samples. Market-to-book ratio has positive effect on

book leverage, supporting market timing theory that firms tend to issue equity instead of debt

when market value is high (Baker and Wurgler, 2002). However, it is negatively associated

with market leverage, in accordance with pecking order theory. We also discover that, as

expected, sales growth is positively related to leverage in firms with intermediate OC, but the

relation is negative in other samples, due to the high yield bond problem in the UK. Firms

maintain a high debt capacity in capital structure, even those with low sales growth.

The coefficients of tangibility and dividend are negative and significant in the sample of all

security issues, which is contrary to the predictions mentioned before. A possible explanation

is found in pecking order theory, whereby the firm considers debt as the first choice of

external financing, before equity issuance. This finding can also be explained by the fact that

greater debt leads to higher risk of bankruptcy.

The results demonstrate that tax ratio has positive impact on leverage level in high OC firms,

but no impact in the other samples. The coefficient of non-debt tax shield is positive and

significant at 1% level, which is consistent with the argument of Moh’d Perry and Rimbey

(1998). They consider that depreciation is the primary component of non-debt tax shield, and

that higher depreciation charges represent the higher level of tangibility, which implies the

firm’s own higher collateral value and thus the capacity of the firm rises.


Table 5 reveals the impact of ownership concentration on leverage and leverage change

around a security issue, using debt and equity offering respectively. First, we focus on the

effects of ownership concentration and other variables on leverage ratio. The observations of

debt issuance (columns 2 and 3) show that ownership concentration and non-debt tax shield

have significant positive impact on leverage level, but the impact of profitability is adverse.

The results according to market-to-book ratio are mixed. Debt issues contain the data on

credit rating, but not the impact on leverage. However, ownership concentration shows a

negative impact on leverage in the sample of equity issues. In addition, the positive effect of

firm size on leverage is only found in the group of equity offerings.

Second, the evidence shows that the ownership concentration has significant positive impact

on leverage change around security issuances (see columns 5, 8 and 9). Because the

change of leverage with debt issue is positive, the magnitude of leverage change in the firms

with high OC is more than in the firms with dispersed ownership. However, the leverage

change from equity issue is negative, thus the firms with high OC lower their leverage less

than do firms with low OC. This indicates that firms with high OC issue larger amounts of debt

than do low OC firms, so that the leverage level in the high OC firms will increase more than

that in the firms with dispersed ownership. In contrast, the firms with low OC issue greater

amounts of equity and the leverage level reduces more than in firms with high OC.

The coefficient of profitability in columns 4 and 5 is positive and significant, consistent with

most empirical results. According to pecking order theory, if firms need to finance new

investment with external funds, they prefer debt issue rather than equity issue. Firm size also

negatively affects the leverage change by debt issue, but positively impacts leverage change

by equity issue, indicating that large firms tend to issue smaller amounts of debt and more

equity than do small firms. The evidence shown by market-to-book ratio is also consistent

with market timing theory, in that firms tend to issue equity when their market value is high.

The coefficient of tangibility is positive and significant. This is because firms with more

tangibility usually have more assets that can be used as collateral. Tax rate and non-tax debt

shield only have a significant effect on leverage change around debt issue. It can be found

that firms with higher tax rate tend to issue more debt to take advantage of the deductibility of

interest expenses, but non-debt tax shield can be used to substitute for tax shield benefits of

debt, so that firms with greater non-debt tax shield should issue less debt to maintain their

leverage at a low level, supporting the contention by DeAngelo and Masulis (1980).


Figures 1, 2 and 3 present the stock market conditions during 1997-2009, measured by

cumulative market return, P/E ratio and cumulative equity volume. From Figure 1 we can

observe that the stock market is cold during the second quarter of 2002 and third quarter of

2008, whereas in 2009 the stock market is bullish. Figure 2 shows that at the beginning of

2001, P/E ratio is quite high. At the same time, the equity volumes are clustered, which also

occurs in the first and third quarters of 2009. From this, we find that stock market conditions

are quite different, depending on the measures. Thus we apply each measure to separate the

research period into three stock market conditions: hot, median and cold.

(Please insert Figures 1, 2 and 3 here)

Based on the analysis above, we then verify the proposition that the impact of ownership

concentration on leverage changes around security issuance varies according to different

stock market conditions. As revealed from columns 2, 3, 4 and 5 of Table 6, the coefficient of

OC is insignificant but the coefficient of D1 is statistically significant. The essential implication

of these results is that ownership concentration has no impact on leverage change when the

stock market is cold; the impact only exists in median and hot stock market conditions. The

other two robust tests, in which the stock market is measured by P/E ratio and cumulative

equity volume, suggest that the positive relation between ownership concentration and firms’

external financing activity is monotonic under various stock market conditions.


4 Conclusion

In this paper, the relation between firms’ ownership concentration and leverage level has been

analyzed. Moreover, the impact of ownership concentration on leverage change around bond

and equity issues has been tested, and this impact has been further examined in different

stock market conditions. The data of ownership concentration for 365 UK firms during the

calendar years 1997-2009 was hand-collected. The sample consists of 273 debt and 289

equity issues downloaded from Thomson ONE Banker, with matched accounting data drawn

from DataStream. The sample excludes financials and utilities. In addition, IPO related equity

issues were removed from the sample, because we focus here on listed firms.

We find that ownership concentration does have significant impact on firms’ leverage level.

The effect is non-monotonic, changing across the various levels of ownership concentration. In

firms with dispersed ownership, the effect is positive, but it is absent in firms whose ownership

concentration level exceeds 25%. The findings further confirm the agency conflict between

managers and shareholders, implying that debt financing is not only an effective instrument to

assist external shareholders and bondholders to monitor corporate management, but also that

higher debt capacity protects firms from becoming the target of hostile takeover. Moreover, the

results show that the effects of profitability, sales growth and tangibility and dividend are

negative and significant. However, the impact of firm size, Mb ratio and non-debt tax shield on

leverage are positive and significant.

The evidence demonstrated strongly supports hypothesis 2. The change of debt capacity

around security offers has positive impact on ownership concentration. In other words, the

magnitude of the decline (rise) in leverage by issue equity (debt), is greater (smaller) in firms

with high ownership concentration than in firms with dispersed ownership, which is consistent

with Lundstrum (2009). In particular, the relation between ownership concentration and

leverage change around security issuance does indeed depend on the circumstances of the

stock market. There is evidence that this relation does not exist when the stock market is cold,

but only under hot and median stock market conditions.

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Table 1 Variable definition and measures

Market equity is common shares outstanding times the stock price. Market value is defined as total liabilities minus deferred taxes and investment credit, and then plus preferred stock

and market equity. Book equity is defined as total asset minus total liability, then plus deferred taxes and investment tax credit minus preferred stock. Book debt is total asset minus

book equity.

Variables Definition and measure Data Source

(1) Book leverage Book debt / total asset Thomson DataStream

(2) Market leverage Book debt / market value Thomson DataStream

(3) Book change Leverage change / total asset Thomson One Banker

(4) Market change Leverage change / market value Thomson One Banker

(1) OC The sum of percentages of block shareholder (>5%) owned shares. Thomson One Banker

(2) Profitability EBITDA: earnings before interest, tax, depreciation Thomson DataStream

(3) Firm size Log of total sales Thomson DataStream

(4) Market-to-book ratio Market value of asset/ book asset Thomson DataStream

(5) Sell growth Change in log of total asset Thomson DataStream

(6) Asset tangibility Plant property and equipment/ total asset Thomson DataStream

(7) Credit rating A dummy variable that equals one if firm’s rating is above A- and zero below A-, referring to S&P bond

rating

Thomson One Banker

(8) Dividend Dividend payout ratio Thomson DataStream

(9) Tax rate Ratio of taxes paid to pre-tax income Thomson DataStream

(10) Non-debt tax shield Depreciation/ total asset Thomson DataStream

(11) Equity issue volume The cumulative volume of monthly equity issues (A three months de-trended moving average of equity

issue of each month)

Thomson DataStream

(12) P/E ratio Average monthly ratio Thomson DataStream

(13) Cumulative market returns Annual Value-Weighted Index return. Thomson DataStream

Table 2 Descriptive statistics of all companies

This table reports the descriptive statistics of the sample of 365 companies over 1997-2009, excluding financials and utilities. The sample is further separated into four groups: all firms, high ownership

concentrated firm (high OC), intermediate ownership concentrated firm (intermediate OC), and low ownership concentrated firm (low OC). Book leverage is defined as book debt over total asset.

Market leverage is the ratio of book debt to market value. OC represents the sum of shares held by block holders. Profitability is the earnings before interest, taxes and depreciation (EBITDA) over

total debt. Firm size is expressed as the log of total sales. Mb ratio is market value of asset. Sales growth is measured by change in log of total asset. Tangibility is calculated as tangible asset over

total asset. Dividend expresses common dividend payout ratio. Tax rate is defined as ratio of taxes paid to pre-tax income. Non debt tax shield denotes non-debt tax shield.

All companies High OC Intermediate OC Low OC

No. Obs Mean Std No. Obs Mean Std No. Obs Mean Std No. Obs Mean Std

Book leverage 12025 0.5692 0.2681 2478 0.5023 0.2441 3989 0.5709 0.2446 5558 0.5978 0.2884

Market leverage 11454 0.3752 0.1934 2391 0.3452 0.2102 3867 0.3863 0.1926 5196 0.3808 0.1842

OC 11472 0.3352 0.2451 2478 0.6684 0.2825 3989 0.3614 0.7114 5005 0.1495 0.06519

Profitability 12014 0.1340 0.1644 2476 0.1390 0.1665 3983 0.1262 0.1563 5555 0.1374 0.1689

Firm size 11777 12.9546 1.9469 2447 12.1888 1.7518 3954 12.6858 1.6392 5376 13.5009 2.0769

Mb ratio 11454 1.9598 1.8743 2391 2.0485 2.2584 3867 1.8104 1.3540 5196 2.0302 2.0022

Sales growth 11860 0.0605 0.1507 2462 0.0627 0.1590 3967 0.0574 0.1477 5431 0.0617 0.1491

Capital expenditure 10312 0.0616 0.1815 2230 0.0555 0.0867 3504 0.0560 0.0869 4578 0.0689 0.2543

Tangibility 11987 0.3087 0.2486 2478 0.3581 0.2688 3984 0.2780 0.2332 5525 0.3086 0.2463

Dividend 11394 0.0895 0.1236 2414 0.0633 0.1136 3822 0.0756 0.0816 5158 0.1120 0.1477

Tax rate 10190 0.35977 0.9902 2015 0.3290 0.3660 3318 0.3309 0.2925 4857 0.3922 1.3352

Non debt tax shield 11765 0.0371 0.0306 2414 0.0420 0.0350 3886 0.0364 0.0298 5465 0.0354 0.0289

Table3 Issues distribution and firm characteristics of debt and equity issues

The sample consists of all the equity and bond issues from 1997 to 2009. The sample excludes utilities and financials. This table includes the firm statistics of the 273 debt and 289 equity issues over

1997-2009. The sample is further separated into four groups: all issues, high ownership concentrated firms (high OC), intermediate ownership concentrated firms (intermediate OC), and low

ownership concentrated firms (low OC). Book leverage is defined as book debt over total asset. Market leverage is the ratio of book debt to market value. OC represents the sum of shares held by

block holders. Profitability is the earnings before interest, taxes and depreciation (EBITDA) over total debt. Firm size is expressed as the log of total sales. Mb ratio is market value of asset. Sales

growth is measured by change in log of total asset. Tangibility is calculated as tangible asset over total asset. Dividend expresses common dividend payout ratio. Tax rate is defined as ratio of taxes

paid to pre-tax income. Non debt tax shield denotes non-debt tax shield. Prin Amt is the principal amount of issuers. Pro Amt is the proceed amount of the issue.

Panel A Debt and equity issues sample distribution

Debt issues Equity issues

Year No. of Obs Prin Amt Pro Amt No. of Obs Prin Amt Pro Amt

1997 97 164.31 164.42 154 105.39 68.44

1998 84 198.16 196.48 154 159.65 106.8

1999 102 265.65 257.66 144 210.93 129.43

2000 126 388.05 385.68 376 165.70 81.86

2001 104 292.87 292.23 383 221.92 79.24

2002 114 257.74 257.12 278 174.37 63.17

2003 100 270.96 270.99 340 44.08 26.23

2004 77 342.65 341.75 358 58.30 37.7

2005 61 368.44 367.42 174 89.25 77.78

2006 113 373.44 372.24 188 98.93 82.53

2007 103 487.99 486.04 318 73.42 57.94

2008 52 625.25 619.23 328 103.30 61.21

2009 71 333.19 331.09 532 149.62 85.21

sum 1216 327.22 325.31 3733 127.17 69.69

Panel B Firm characteristics for debt issues

All debt issues High OC Intermediate OC Low OC

No.

Obs Mean Std No. Obs Mean Std No. Obs Mean Std No. Obs Mean Std

Book leverage 273 0.6195 0.2674 12 0.7509 0.2659 51 0.6648 0.2185 210 0.6009 0.2758

Market leverage 271 0.4102 0.1451 12 0.6094 0.1608 49 0.4994 0.1505 210 0.3780 0.1242

OC 273 0.1900 0.1438 12 0.6746 0.4370 51 0.3335 0.5640 210 0.127571 0.6014

Profitability 273 0.1291 0.1112 12 0.1514 0.0396 51 0.0872 0.1836 210 0.1379 0.0862

Firm size 273 15.5093 1.4899 12 13.8567 0.6095 51 14.2863 1.1957 210 15.9008 1.3608

Mb ratio 271 1.6072 0.9111 12 1.2100 0.2236 49 1.4038 0.4689 210 1.6774 0.9978

Sales growth 273 0.0555 0.0853 12 0.0968 0.1368 51 0.0444 0.0855 210 0.0558 0.0812


Tangibility 273 0.3855 0.2656 12 0.4738 0.1855 51 0.3267 0.2789 210 0.3948 0.2646

Dividend 273 0.1372 0.1868 12 0.0557 0.0624 51 0.0792 0.0681 210 0.1559 0.2062

Tax rate 226 0.5084 1.0499 8 0.3626 0.1227 48 0.3397 0.3027 170 0.5630 1.1955


Prin Amt 250 271.8311 249.6657 12 268.9558 247.9231 50 279.3272 282.1483 188 270.0210 241.8786

Pro Amt 253 278.9378 259.8389 12 268.7392 247.7032 50 278.8434 281.4302 191 279.6033 256.0520

Panel C Firm characteristics for equity issues

All equity issues High OC Intermediate OC Low OC

No.

Obs Mean Std No. Obs Mean Std No. Obs Mean Std No. Obs Mean Std

Book leverage 289 0.6124 0.3292 70 0.5399 0.2553 98 0.5948 0.2983 121 0.6686 0.3798

Market leverage 273 0.4330 0.2206 65 0.3820 0.2433 95 0.4268 0.2133 113 0.4675 0.2085

OC 289 0.3523 0.2196 70 0.6720 0.1074 98 0.3720 0.6796 121 0.1515 0.0692

Profitability 289 0.1284 0.1634 70 0.1903 0.2039 98 0.1080 0.1329 121 0.1091 0.1514

Firm size 284 12.9309 2.0503 69 12.2477 1.7610 97 12.3946 1.9019 118 13.7712 2.0425

Mb ratio 273 1.7947 1.9971 65 2.5347 3.7482 95 1.6305 0.9523 113 1.5070 0.6877

Sales growth 286 0.1263 0.2401 70 0.1359 0.1963 98 0.1044 0.1458 118 0.1388 0.3153


Tangibility 289 0.3044 0.2548 70 0.3616 0.2723 98 0.2698 0.2484 121 0.2993 0.2456

Dividend 277 0.0859 0.1709 67 0.0341 0.0509 95 0.0457 0.0512 115 0.1494 0.2451

Tax rate 231 0.7943 433.2275 59 0.3030 0.1835 79 0.3303 0.2211 93 1.5000 6.7835


Prin Amt 275 163.4793 176.6760 68 107.5887 96.5375 98 139.4313 165.7392 109 219.9680 207.4292

Pro Amt 280 110.3199 144.4776 68 72.7479 85.6825 98 103.4508 141.9315 114 138.6363 167.9090

Table 4 The impact of ownership concentration on firms’ leverage ratio by all companies

This table includes 365 UK firms over 1997-2009. The sample excludes utilities and financials. The sample is further separated into four groups: high ownership concentrated firms (high OC),

intermediate ownership concentrated firms (intermediate OC), and low ownership concentrated firms (low OC). Book leverage is defined as book debt over total asset. Market leverage is the ratio of

book debt to market value. OC represents the sum of shares held by block holders. Profitability is the earnings before interest, taxes and depreciation (EBITDA) over total debt. Firm size is

expressed as the log of total sales. Mb ratio is market value of asset. Sales growth is measured by change in log of total asset. Tangibility is calculated as tangible asset over total asset. Dividend

expresses common dividend payout ratio. Tax rate is defined as ratio of taxes paid to pre-tax income. Non debt tax shield denotes non-debt tax shield. ***, **,* denote statistical significance at the 1%,

5% and 10% levels, respectively.

Leveraget = α0 + α1OCt + α2Profitabilityt + α3firmsizet + α4Mbratiot + α5salesgrowtht+ α6tangibilityt + α7dividendt + α8taxratet + α9nondebttaxshieldt + ut

All companies High OC Intermediate OC Low OC

Book leverage Market leverage Book leverage Market leverage Book leverage Market leverage Book leverage Market leverage

Constant 0.25235*** 0.27944*** 0.02312 0.12716*** -0.40057*** 0.04973* 0.15061*** 0.35539***

[0.03619] [0.0215] [0.04307] [0.03366] [0.04667] [0.02933] [0.03031] [0.02046]

OC -0.00116*** 0.000441*** 0.000183 1.94E-05 0.00081 -0.00031 0.00166** 0.00188***

[0.000197] [0.000117] [0.000155] [0.000121] [0.000544] [0.000342] [0.000518] [0.00035]

Profitability -0.03951 -0.79332*** -0.29669*** -0.66044*** 0.12244** -0.69658*** -0.38839*** -0.76735***

[0.05821] [0.03458] [0.05539] [0.04328] [0.06183] [0.03886] [0.05294] [0.03573]

Firm size 0.0285*** 0.01865*** 0.04269*** 0.02567*** 0.06651*** 0.0388*** 0.02641*** 0.0118***

[0.00245] [0.00145] [0.00309] [0.00242] [0.00292] [0.00183] [0.00194] [0.00131]

Mb ratio 0.03398*** -0.01368*** 0.02297*** -0.01919*** 0.03029*** -0.05001*** 0.06257*** -0.03624***

[0.00219] [0.0013] [0.00258] [0.00202] [0.00381] [0.0024] [0.00245] [0.00165]

Sales growth -0.16372*** -0.09485*** -0.1011** 0.00214 0.18021*** 0.16109*** -0.10681*** -0.0875***

[0.02933] [0.01742] [0.03949] [0.03086] [0.03729] [0.02344] [0.02768] [0.01869]

Tangibility -0.3418*** -0.03059** -0.18389*** 0.00665 -0.11337*** 0.03553** -0.14792*** 0.01483

[0.02482] [0.01475] [0.02128] [0.01663] [0.02211] [0.01389] [0.01545] [0.01043]

Dividend -0.0005* -0.00057*** -0.00082* 0.00218*** 0.00109** 9.65E-05 -0.00027 -0.00014

[0.000285] [0.000169] [0.000421] [0.000329] [0.000505] [0.000318] [0.000235] [0.000159]

Tax rate 1.95E-05 1.32E-05 0.000321** 0.00036*** 0.00018 -2.80E-05 7.60E-06 1.54E-06

[2.28E-05] [1.35E-05] [0.000137] [0.000107] [0.000134] [8.42E-05] [2.08E-05] [1.41E-05]

Non debt tax

shield 1.55165*** 0.68649*** 0.55295*** 0.63904*** 1.05987*** 0.91924*** 1.68393*** 1.04162***

[0.21489] [0.12765] [0.18893] [0.14762] [0.18364] [0.11542] [0.14517] [0.098]

R2 0.2105 0.4243 0.2007 0.3406 0.1833 0.4387 0.2195 0.3717

Adjusted R2 0.2083 0.4227 0.1969 0.3375 0.1809 0.437 0.2178 0.3703

Table 5 The impact of ownership concentration on leverage and leverage change by security issues

This table includes 273 debt and 289 equity issues over 1997-2009. The sample excludes utilities and financials. Book leverage is defined as book debt over total asset. Market leverage is the ratio

of book debt to market value. Book change is the ratio of proceed amount of security issuance to total asset. Market change is the ratio of proceed amount to market value. OC represents the sum of

shares held by block holders. Profitability is the earnings before interest, taxes and depreciation (EBITDA) over total debt. Firm size is expressed as the log of total sales. Mb ratio is market value of

asset. Sales growth is measured by change in log of total asset. Capital represents the ratio of capital expenditure to total asset. Tangibility is calculated as tangible asset over total asset. Dividend

expresses common dividend payout ratio. Tax rate is defined as ratio of taxes paid to pre-tax income. Non debt tax shield denotes non-debt tax shield. ***, **,* denote statistical significance at the

1%, 5% and 10% levels, respectively.

Leveraget = α0 + α1OCt + α2Profitabilityt + α3firmsizet + α4Mbratiot + α5salesgrowtht+ α6tangibilityt + α7dividendt + α8taxratet + α9nondebttaxshieldt + ut

Leverage change = α0 + α1OCt +α2Profitabilityt + α3firmsizet + α4Mbratiot + α5salesgrowtht+ α6tangibilityt + α7dividendt + α8taxratet + α9nondebttaxshieldt + α10creditratingt + ut

Debt issues Equity issues

Book leverage Market leverage Book change Market change Book leverage Market leverage Book change Market change

Constant 0.10482 0.40729*** 0.61552*** 0.20151*** 0.26696* 0.09972 -0.26602*** -0.13523***

[0.18058] [0.11855] [0.18578] [0.02552] [0.15315] [0.09111] [0.04446] [0.01752]

OC 0.00271*** 0.00272*** 0.00174 0.000456*** -0.00202** 0.000193 0.000628** 0.000215**

[0.000945] [0.00062] [0.00106] [0.000146] [0.000875] [0.000521] [0.000254] [0.0001]

Profitability -0.35048 -0.618*** 0.57589* 0.13416*** -0.57676** -0.61581*** -0.21009*** 0.00687

[0.27121] [0.17805] [0.29391] [0.04038] [0.23035] [0.13704] [0.05963] [0.0235]

Firm size 0.01378 0.00513 -0.05388*** -0.01376*** 0.02942*** 0.02426*** 0.01785*** 0.00765***

[0.01068] [0.00701] [0.011] [0.00151] [0.01051] [0.00625] [0.00291] [0.00115]

Mb ratio 0.1943*** -0.02803** 0.1067*** -9.90E-05 0.07116*** 0.00297 -0.02506*** 0.00252*

[0.01688] [0.01108] [0.01818] [0.0025] [0.01295] [0.0077] [0.00362] [0.00142]

Sales growth 0.17069 0.11784 0.11313 0.02213 -0.20825* -0.09608* -0.01418 -0.00629

[0.13717] [0.09005] [0.01818] [0.02149] [0.09082] [0.05403] [0.02674] [0.01054]

Tangibility -0.35792*** -0.18823*** 0.08682 0.03301*** -0.00596 0.32945*** 0.05457** 0.00803

[0.05248] [0.03445] [0.05348] [0.00735] [0.07785] [0.05403] [0.02154] [0.00849]

Dividend -0.00022 -0.00022 -0.00059 2.32E-05 -0.00127 -0.00063 -7.30E-05 -4.70E-06

[0.000568] [0.000373] [0.000596] [8.19E-05] [0.00154] [0.000918] [0.00067] [0.00849]

Tax rate -0.00023** -8.90E-05 0.000261*** 4.16E-05*** -1.20E-05 -6.60E-06 -3.20E-06 2.18E-06

[0.00011] [7.23E-05] [7.25E-05] [9.95E-06] [3.94E-05] [2.35E-05] [1.18E-05] [4.65E-06]

Non debt tax shield 3.804*** 2.37927*** -1.22779** -0.32232*** 1.06704 -0.68033 0.04184 -0.20785*

[0.56326] [0.36977] [0.58807] [0.08079] [0.78653] [0.4679] [0.21219] [0.08362]

Credit rating 0.000867 -0.01474 0.00302 -0.00035

[0.0308] [0.02019] [0.03347] [0.0046]

R2 0.6577 0.494 0.4234 0.4912 0.2326 0.4384 0.6045 0.2273

Adjusted R2 0.6393 0.4667 0.3992 0.4698 0.1954 0.4111 0.5891 0.1972

Figure 1 Stock market conditions measured by cumulative market return

‐0.3

‐0.25

‐0.2

‐0.15

‐0.1

‐0.05

0

0.05

0.1

0.15

0.2

0.25

Q1 1997

Q3 1997

Q1 1998

Q3 1998

Q1 1999

Q3 1999

Q1 2000

Q3 2000

Q1 2001

Q3 2001

Q1 2002

Q3 2002

Q1 2003

Q3 2003

Q1 2004

Q3 2004

Q1 2005

Q3 2005

Q1 2006

Q3 2006

Q1 2007

Q3 2007

Q1 2008

Q3 2008

Q1 2009

Q3 2009

Cumulative Market Return

Figure 2 Stock market conditions measured by P/E ratio

0

20

40

60

80

100

120

140

160

180

200

Q1 1997

Q3 1997

Q1 1998

Q3 1998

Q1 1999

Q3 1999

Q1 2000

Q3 2000

Q1 2001

Q3 2001

Q1 2002

Q3 2002

Q1 2003

Q3 2003

Q1 2004

Q3 2004

Q1 2005

Q3 2005

Q1 2006

Q3 2006

Q1 2007

Q3 2007

Q1 2008

Q3 2008

Q1 2009

Q3 2009

P/E ratio

Figure 3 Stock market conditions measured by cumulative equity volume

0

5000

10000

15000

20000

25000

Q1 1997

Q3 1997

Q1 1998

Q3 1998

Q1 1999

Q3 1999

Q1 2000

Q3 2000

Q1 2001

Q3 2001

Q1 2002

Q3 2002

Q1 2003

Q3 2003

Q1 2004

Q3 2004

Q1 2005

Q3 2005

Q1 2006

Q3 2006

Q1 2007

Q3 2007

Q1 2008

Q3 2008

Q1 2009

Q3 2009

Cumulative Equity Volume

Table 6 The impact of ownership concentration on leverage change under different stock market conditions

This table includes 273 debt and 289 equity issues over 1997-2009. The sample excludes utilities and financials. Three measures are applied - cumulative market returns, P/E ratio and cumulative

equity volumes - to divide stock market into cold, median and hot conditions respectively. Book change is the ratio of proceed amount of security issuance to total asset. Market change is the ratio of

proceed amount to market value. OC represents the sum of shares holding by block holder. Profitability is the earnings before interest, taxes and depreciation (EBITDA) over total debt. Firm size is

expressed as the log of total sales. Mb ratio is market value of asset. Sales growth is measured by change in log of total asset. Tangibility is calculated as tangible asset over total asset. Dividend

expresses common dividend payout ratio. Tax rate is defined as ratio of taxes paid to pre-tax income. Non debt tax shield denotes non-debt tax shield. D1 is defined as OC times cold stock market

dummy. D2 is defined as OC times hot stock market dummy. Cold stock market condition is a dummy variable equal to 0 when the stock market condition is ranked in the bottom 30%, and 1

otherwise. Hot stock market is also a dummy variable, equal to 1 when the stock market condition is in the top 30% of the whole research period and 0 otherwise.***, **,* denote statistical

significance at the 1%, 5% and 10% levels, respectively.

Leverage change = α0 + α1OCt + α2D1t + α3D2t + α4Profitabilityt + α5firmsizet + α6Mbratiot + α7salesgrowtht+ α8tangibilityt + α9dividendt + α10taxratet + α11nondebttaxshieldt + α12creditratingt + ut

Cumulative market returns P/E ratio Cumulative equity volumes

Debt issues Equity issues Debt issues Equity issues Debt issues Equity issues

Book

change

Market

change

Book

change

Market

change

Book

change

Market

change

Book

change

Market

change

Book

change

Market

change

Book

change

Market

change

Constant 0.55849*** 0.18663*** -0.2812*** -0.1384*** 0.60245*** 0.20318*** -0.2808*** -0.1451*** 0.58543*** 0.20598*** -0.28071*** -0.14565***

[0.19224] [0.02609] [0.04407] [0.01752] [0.16981] [0.02337] [0.04469] [0.0176] [0.17004] [0.02315] [0.04481] [0.01769]

OC 0.000926 0.000259 0.000218 5.37E-05 0.00266** 0.00055*** 0.000748*** 0.000302*** 0.00198* 0.000516*** 0.000564** 0.000212**

[0.00118] [0.000161] [0.000307] [0.000122] [0.00118] [0.000162] [0.00027] [0.000106] [0.00114] [0.000155] [0.000271] [0.000107]

D1 0.00232* 0.000523*** 0.000514** 0.000224** -0.00184 -0.00015 0.000319 0.0001654 -0.00148 -0.00046** 0.000447 0.000251**

[0.00121] [0.000164] [0.000253] [0.0001] [0.00139] [0.000192] [0.000291] [0.000114] [0.00145] [0.000198] [0.000299] [0.000118]

D2 -0.00181 -0.00033* 0.000542* -2.80E-05 -0.00183 -0.0002 -0.00039 -0.000249** -0.00051 -0.00015 2.95E-05 -7.975E-05

[0.00131] [0.000177] [0.000324] [0.000129] [0.00117] [0.000161] [0.000259] [0.000102] [0.00114] [0.000155] [0.000259] [0.000102]

Profitabilit

y 0.61757** 0.14416*** -0.17812*** 0.01654 0.61425** 0.13556*** -0.2225*** 0.00148 0.62865** 0.14569*** -0.20162*** 0.01539

[0.00131] [0.03988] [0.05977] [0.02377] [0.2931] [0.04034] [0.05964] [0.02349] [0.29484] [0.04014] [0.05954] [0.0235]

Firm size -0.05118*** -0.01303*** 0.01886*** 0.00792*** -0.05391*** -0.01393*** 0.01834*** 0.00786*** -0.05189*** -0.01388*** 0.01855*** 0.00805***

[0.00131] [0.00153] [0.00289] [0.00115] [0.01024] [0.00141] [0.00293] [0.00115] [0.01022] [0.00139] [0.00295] [0.00116]

Mb ratio 0.1057*** -0.00031 -0.02589*** 0.00243* 0.10598*** -8.6E-05 -0.02379*** 0.00331** 0.10441*** -0.00077 -0.02455*** 0.00273*

[0.01811] [0.00246] [0.00358] [0.00142] [0.01821] [0.00251] [0.00363] [0.00143] [0.01831] [0.00249] [0.00364] [0.00144]

Sales

growth 0.17192 0.03636* -0.00454 -0.00428 0.16842 0.02635 -0.00694 -0.00146 0.12632 0.01959 -0.01124 -0.00409

[0.16072] [0.02181] [0.02653] [0.01055] [0.15307] [0.02107] [0.02672] [0.01052] [0.15354] [0.0209] [0.02669] [0.01053]

Tangibility 0.09498* 0.03448*** 0.05092** 0.00706 0.10977** 0.03507*** 0.05617** 0.01053 0.0925* 0.03361*** 0.05647*** 0.01164

[0.05362] [0.00728] [0.02125] [0.00845] [0.05404] [0.00744] [0.02112] [0.00832] [0.05316] [0.00724] [0.02137] [0.00844]

Dividend -0.0005 4.03E-05 -0.00017 -4.30E-05 -0.00047 3.94E-05 -0.00014 -4.99E-05 -0.00065 9.15E-06 -0.00011 -3.678E-05

[0.000595] [8.07E-05] [0.000662] [0.000263] [0.000604] [8.31E-05] [0.000668] [0.000263] [0.000599] [8.15E-05] [0.000669] [0.000264]

Tax rate 0.000261*** 4.15E-05*** -2.80E-06 2.30E-06 0.000286*** 4.4E-05*** -5.7E-06 -1.76E-07 0.000266*** 4.31E-05*** -5.8E-06 -1.98E-07

[7.23E-05] [9.81E-06] [1.16E-05] [4.62E-06] [7.37E-05] [1.01E-05] [1.16E-05] [4.55E-06] [7.26E-05] [9.89E-06] [1.16E-05] [4.59E-06]

Non debt

tax shield -1.34848** -0.3466*** -0.01158 -0.23369*** -1.42365** -0.34071*** 0.09323 -0.17678** -1.30398** -0.34842*** 0.00598 -0.2364***

[0.58917] [0.07995] [0.21117] [0.08396] [0.59917] [0.08247] [0.21255] [0.08371] [0.59489] [0.08099] [0.21364] [0.08432]

Credit

rating 0.00378 -0.00028 -0.00094 -0.00045

-0.00531 -0.00192

[0.03337] [0.00453] [0.03286] [0.00452] [0.03349] [0.00456]

R-Square 0.6577 0.494 0.6192 0.2426 0.4294 0.4945 0.6103 0.2396 0.425 0.5017 0.6067 0.2293

R-Sq 0.6393 0.4667 0.6013 0.207 0.4032 0.4712 0.5935 0.2069 0.3985 0.4788 0.5898 0.1962

Documents

Company Ownership and Capital Structure